The muni market has finally taken a break after a breathtaking start to the year (see our piece http://www.cumber.com/commentary.aspx?file=013012.asp).
Here is a table showing the Municipal Market Advisors yields from the end of the year until now:
MMA |
12/30/2011 |
1/31/2012 |
2/29/2012 |
3/20/2012 |
2 |
0.47 |
0.44 |
0.45 |
0.50 |
5 |
1.10 |
0.98 |
1.03 |
1.17 |
10 |
2.28 |
2.15 |
2.24 |
2.51 |
30 |
4.22 |
4.02 |
4.13 |
4.38 |
The reasons for some of this market backup are really threefold
1. US Treasury yields have risen. Since the beginning of February, Treasury yields are 40 basis points higher in the 5-10 year range and 35 basis points higher in the 30-year range. This, of course, is coming from an extremely overbought Treasury market. There was better news on the economy, a drop in the unemployment rate, and the compelling case for higher-dividend blue-chip stocks that were yielding more than the 10-year Treasury (currently 2.3% but 1.9% at the beginning of February).
2. Nominal low municipal yields. Though municipal bonds were extremely cheap on a ratio basis (and still are cheap, but less so), the nominal level of municipal yields had reached levels in the intermediate range not seen since the late 1960s. Certainly there was a pause, from a retail flow standpoint. Bond fund flows – which were very strong to start the year – have recently subsided to still-positive but lower levels.
3. Supply. The Bond Buyer Visible Supply (measuring the new-issue calendar plus supply, which is in dealer hands) started the year around $4 billion and was still only $4.5 billion in early February. It has now risen to over $12 billion. While this is very manageable from a historical basis, it is clearly much higher than it had been and reflects not only the traditional pickup in issuance from year-end doldrums, but also the fact that near-historic lows in interest rates are starting to attract issuers to the market to sell debt.
So where do we go from here?
We believe that municipal bond rates could rise further but, given the much overbought condition in the Treasury market, the rise in tax-free bond rates should be much more muted than Treasuries. Long-maturity yield ratios on the highest-rated bonds were at the absurdly high ratio of 150% last October. Those ratios are down to 115-120% now. Using more normal ratios (e.g., the 85-95% present before the financial crisis), one would conclude that municipal bonds still offer large amounts of relative value, so yields should rise more slowly. In addition, as the municipal/Treasury ratio creeps back to normal, there will be many opportunities for municipalities to advance-refund older, higher-coupon debt sold during the post-Lehman days of 2009 and the Meredith Whitney scare of 2011. This will provide additional capital gains for those refunded bonds, relative to the market. We also believe that, even though the overall story on municipal credit has gotten better, surveillance on individual issues has become more important than ever – in great part due to headline risk regarding pensions and other costs at local levels.
At Cumberland we continue to ratchet down durations in accounts from the levels of last year and, as mentioned, we remain vigilant on credit. As supply picks up there should be opportunities available in the new-issue market that have not been present since early fall of last year. We will keep readers informed. |